n Expert opinion — Liquidnet

Liquidity transfer due to the activity of proprietary and institutional liquidity seeking algorithms
make lit and dark liquidity intimately intertwined.

Based on our observations we believe that this
entanglement of dark and lit liquidity often has
material impact on how less opportunistic, scheduled and participation algorithms may perform in
the wider market.

Let us take a look at how traditional, lit-market onlyalgorithms trade two offsetting institutional ordersvia VWAP or POV (Figure 1). Buyers and sellers dripfeed liquidity to the market. If there are no exogenousdisruptions, a fragile equilibrium exists. Relativelybalanced interaction between buyers and sellersresults in relatively stable price: both algorithms inthe end trade at an average price over an extendedtime period. In this theoretical example the priceanalytics which facilitateefficient liquidity manage-ment and identification oftrading patterns across darkand lit venues. When a SORdecides whether to exploredark venues, to post lit,or to take advantage of anoversized lit offer, its activ-ity ties dark and lit liquiditytogether.

The dark liquidity
myth

The sanctity of the dark in
minimising information
leakage is considered vital
to buy-side institutions.

However, no two dark pools
are the same. Execution quality varies from one dark
venue to another and is never static.

It has been known for a long time that proprietary
high frequency trading across lit and retail sized
dark venues provides a transmission mechanism for
imbalance in dark to impact lit. Due to their proprietary, short-lived and bi-directional nature, their
price impact on markets is often contained. Modern
liquidity-seeking algorithms now perform a similar
liquidity transfer function in the institutional space.
The natural orders originating in large asset managers may have a more pronounced and less contained
impact on price.

Even though the nominal average dark volume
can be around 1/10 of lit volume in EMEA1, it is

1. For example, according to BATS market share data (http://batstrading.
co.uk/market_data/market_share/market/) , on Aug 17, 2016 the 5-day
average lit and dark market volumes in EMEA were € 29.8B and €2.7B,
respectively. The latter did not include dark flow in Broker Crossing
Networks (BCNs). According to our data, BCNs may have added another
€500M or more of daily dark trading for this period.
Based on internal Liquidnet transaction cost analysis data since the
beginning of 2016 through July 2016.